Wheel of fortune

The year of living dangerously Emerging markets go to the polls

A series of elections in emerging markets may bring unwelcome uncertainty for investors in 2018.

After two years in which political risk gripped the West, the spotlight is back on emerging economies.

Twenty-seven emerging or frontier markets are due to go to the polls in 2018, and the outcome of these elections could have big implications for investors. Victory for a reformist leader often sends equity markets soaring, while a populist triumph can have the opposite effect.

Not all of the numerous local and national elections this year will grab headlines, but votes in countries with established capital markets will be scrutinised closely. Events in Russia, Brazil and Mexico, three of the largest emerging economies, will be of particular interest. 

Each of these economies is benefiting from the upswing in global growth. The commodity-driven equity markets of Brazil and Russia, in particular, have rallied substantially from cyclical lows, with investors tempted by the prospect of earnings recoveries. There have been record flows into emerging market debt in these nations as well, as investors look to take advantage of relative value opportunities in an improving economic environment.

But investors in should be mindful that political developments could prompt near-term volatility. New dynamics are introducing uncertainty into the political process. Russia’s Vladimir Putin is reportedly using cyber propaganda techniques to cement his position. In Latin America, young electorates frustrated by corruption are fuelling the rise of entirely new candidates – some of whom are market-friendly, some of whom are not. 

So what are the potential outcomes of the upcoming elections in Russia, Mexico and Brazil? And how will the fallout affect investment assets across emerging markets?

Russia: Putin’s progress?

First in the calendar is the presidential election in Russia in March 2018, where Putin is expected to win a fourth term in office. Alternatives are thin on the ground; even the glamorous television personality Ksenia Sobchak, hailed as a ‘protest’ candidate in some media outlets, is Putin’s goddaughter.

Putin has a commanding lead in the polls and can draw on a sophisticated network of cyber propaganda. The Russian government has taken flak from Western leaders for alleged interference in their affairs – notably during the US presidential election in 2016, when Russian ‘bots’ allegedly disseminated pro-Trump messages on social media. Putin will be able to draw on this technology to sway opinion at home, despite growing dissatisfaction with government corruption among young voters.

This doesn’t mean the status quo will remain entirely unchanged in the run-up to the election. Russia has recently experienced a period of austerity, which has led some quality-of-life metrics to deteriorate. Mindful of potential unrest among voters in the pre-election period, Putin seems to be softening his stance, according to Will Ballard, head of emerging market equities at Aviva Investors.

“You could see a slight fiscal stimulus coming through to try and further strengthen Putin’s support base,” he says. “It is questionable whether this needs to be done, but it is clear that he would rather come through with a resounding victory. That is a positive driver for the economy in the short term and could boost domestic consumption and investment. The real question is whether such government expenditure is sustainable in the long run.”

The Russian election may also have wider implications. Russia has been building links with China and is pressing into the Middle East to offset the impact of US and European sanctions imposed after its annexation of Crimea in 2014. This geopolitical repositioning would continue under Putin’s expected fourth presidential term. Big Russian energy companies may be among the beneficiaries, says Victoria Kelly-Clark of Global Risk Insights, a consultancy.

“Russia has got its fingers into Algeria, into Syria and Iraq. If a company secured territory from Isis militants in Syria, then they were able to gain access to that territory. Rosneft, Gazprom and some other Russian companies are really taking advantage.” 

EM bond chart

Mexico: from reform to populism

The political outlook in Mexico is more uncertain ahead of its general election in July. The country has a ‘one shot’ voting system, meaning a president can be elected with relatively low overall support. Independent candidates are being allowed to run for the first time, and more than 80 individuals have attempted to drum up support to ensure their names are on the presidential ballot paper.

In the new, plural political environment, voting will encompass selection for municipal positions and Congress as well. This is likely to presage a change in direction after President Enrique Peña Nieto’s tenure. When Peña Nieto and his Institutional Revolutionary Party (PRI) took office in July 2012, his pledges to enact economic reforms and take action on corruption were welcomed by voters and markets alike. The MSCI Mexico Index rose 19.6 per cent between July 2, 2012 and March 31 the following year, strongly outperforming the wider emerging-market index.

But the PRI’s failure to deliver on its promises to tackle corruption has hurt the government’s popularity. There has been a distinct lack of action in response to the Odebrecht scandal, which saw Mexican officials allegedly take bribes from the Brazilian conglomerate in exchange for contracts.

“Latin America has had a history of corruption, and that seems to be one of the single biggest overriding factors influencing voters right now,” says Tim Alt, fixed income portfolio manager at Aviva Investors.

The PRI’s waning legitimacy may allow a populist leader to enter the frame this year. The current front-runner is Andres Manuel López Obrador (known as Amlo), leader of the National Regeneration Movement Party or MORENA. 

Although Congress might prove a restraining force in the case of an Amlo win, his apparently retrogressive stance in energy and education may unsettle markets, says Ballard. “If MORENA comes through on a populist vote, some of the policies have big question marks from an investment standpoint.”

Amlo displays a self-proclaimed “nationalist attitude”, and has pledged to revisit contracts to ensure they are free from corruption and in Mexico’s best interests. His plans to boost investment in infrastructure and social spending are potentially inflationary, and the prospect of a win for MORENA is already being reflected in financial markets through wider credit spreads and a weaker peso.

Meanwhile, the cut in the US corporate tax rate has undercut Mexico’s regime, while the future of the North America Free Trade Agreement (NAFTA) also hangs in the balance. 

“We hope the NAFTA negotiations are resolved with a benign outcome prior to the elections. If they are not, there is an additional risk – given that the campaign rhetoric seems to suggest that neither side really agrees with NAFTA,” says Alt.

Brazil: inflection point

In contrast to Mexico, Brazil’s two-round voting system needs the winning candidate to take at least 50 per cent of the popular vote. An Ipsos survey in late 2017 suggested 94 per cent of Brazilians did not feel represented by their politicians, which has opened up opportunities for alternative candidates to prevail at the general election in October.

Voters’ dissatisfaction with the political elite is understandable: as in Mexico, corruption is a big problem in Brazil. In 2015, millions took to the streets in protest after allegations of money laundering against the former president Luiz Inácio Lula da Silva escalated into a scandal that engulfed huge swathes of the country’s political and business elites. The country’s Supreme Court authorised investigations into the actions of the president, around one third of the cabinet, one third of the senate and numerous state governors.

Former president Dilma Rousseff was impeached for breaking budgetary laws in 2016, and her removal prompted an astonishing rise in Brazil’s equity market that year, as investors became excited about the promise of reform under incoming president Michel Temer. The MSCI Brazil Index rose a remarkable 66.2 per cent, compared with only an 11 per cent rise in the wider MSCI Emerging Markets Index.

Temer – who faces charges of obstruction of justice – will not be able to stand for re-election in October, which raises the question of what comes next. Some had tipped Lula to make a comeback, but he may not be able to stand due to a corruption investigation of his own.

A new candidate could take advantage, according to Carlos Melo, political scientist at the Sao Paulo-based Institute of Education and Research. “If Lula is absent, it would unquestionably open the space for an outsider; an emotional leader,” he says.

Jair Bolsonaro, the right-wing federal deputy for Rio de Janeiro, might fit that description. Often described as Brazil’s answer to Donald Trump, the former military man has drawn on a rich seam of disaffection after a deep recession in which the economy contracted, unemployment rose and social services were cut. Bolsonaro admits having little understanding of economics, and offers no easy solutions to Brazil’s policy challenges, which include the need to broaden and accelerate the economic recovery. With a potential strongman like Bolsonaro in the ascendancy, Brazil may be reaching an inflection point: will it press ahead with political and economic reform or slip back into populism?

Brazil’s experience in recent years has at least brought increased transparency and strengthened opposition to corruption, and that could benefit investors over the longer term, says Ballard. “It comes down to the ability of the judiciary to be able to do their job, to be able to prosecute effectively. Certainly we are seeing great strides being made in Brazil – but we need to see that within other emerging market countries as well.”

The ongoing push-and-pull between populism and reform is likely to be a key feature across emerging markets as they take to the polls in 2018. Given the extreme scenarios in play, investors will need to stress-test and hypothesise all the major outcomes – including the most unlikely – to ensure their portfolios are resilient during the year ahead.

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 15th February, 2018. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.


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The push-and-pull between populism and reform is likely to be a key feature across emerging markets in 2018

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